Download Macroeconomic Indicators

THE
RISE AND FALL OF MONEY
Chapter 2
MONEY AS TECHNOLOGY
Specialization and Exchange
• In a varied economy, producers will specialize in
production of certain goods, yet consume a diverse
set of goods which presents of problem of allocation
of goods.
• Barter – Cumbersome. Difficult to overcome the
double coincidence of wants. Anthropologists find no
evidence of barter based economies.
• Gift-giving - Ritualized voluntary exchanges. Informal debts.
I give you a stone axe today under the presumption that you
will give me a club tomorrow. Informal debts.
Problem with Informal Debts
• As tribe gets bigger and economy becomes more
complex, hard to keep track of value of people’s
obligations.
• Exchange of tokens of value can help people hold
record obligations. “Money as memory.”
• Primitive moneys usually objects of some value (often
decorative).
Necessary Characteristics of Money
•
•
•
•
•
Acceptable (Usable by most traders)
Standardized Quality
Durable
Valuable Relative to Weight
Divisible
By 2500 BCE, precious metal rings were being used as money in
Egypt.
British Museum
Evolution of Money:
Money is a technology that has advanced in sophistication over
time.
• Governments began minting coins for standardization (ca. 700
B.C.). According to Herodotus, ancient kingdom of Lydia had first
coins made of electrum
Oldest
Coins
Paper Money
• Coins in China are traditionally made of bronze
which are heavy relative to value. Tang dynasty
merchants deposited coins at pawn shops and
traded in receipts (900 AD).
• In 12th century, Song empire gov’t
takes over money printing system
and issues first national paper
currency.
Oldest Paper Money,
1375
Fiat Money
• Fiat Money intrinsically worthless item that can be
used as money by government declaration that it is
legal tender.
• Government settles contracts, can declare a
contract settled if fiat money payment is made.
• Tax bills are settled when fiat money payment is
made.
• Currency can be used for trade since it will have
future value.
• Money during Yuan dynasty not backed by precious
metals, only Khan’s decree.
Self Interested Government may have
incentives to increase money supply.
• Government generates revenues by printing new fiat money
(referred to as seignorage).
• Yuan and Ming Dynasty printed money overly rapidly dissipating its
value.
• “ in 1380, one guan was worth 1000 copper coins, in 1535, one guan
valued merely 0,28 copper coin!”
• Paper money became unpopular and was discontinued
Silver dollar
• Paper money introduced in China due to shortage
of metals.
• After Spanish conquest of Mexico/South America
& Philippines, trans-Pacific trade introduced large
quantities of silver to China.
• Spanish dollar and later Mexican dollar became
trading standard in 18th & 19th century Asia (and
USA!).
• Initially, 1 Yuan = 1 Yen = 1 Mexican dollar
Hong Kong Dollar Link
• Hong Kong mint began officially coining dollar
equivalent in 1860’s.
• Standard “British Trade Dollar” defined in 1895 by act
of Parliament. Straits Settlements begin coining their
own currency in 1903 so British Trade dollar becomes
Hong Kong Dollar.
• In 1934, US gov’t begins heavy buying of silver
leading to shortage of coins in Asia.
• Currency Board: Sterling backed Notes of HSBC,
Mercantile Bank [later merged w/ HSBC], Standard
Chartered [and later Bank of China] were defined as
legal tender in 1935.
Evolution of Money
In more advanced societies with sophisticated banking
systems, broad money may be used for transactions.
• Checks: Paper promises to pay definitive money on
demand.
• Electronic Transfers: Funds can be transferred from
account to account in banking system.
• Debit Cards and ATM Cards can be used to transfer
funds to definitive money or in direct exchange for
goods.
MEASURING MONEY IN THE
MODERN WORLD
Defining Money
• Many financial assets and transaction flows.
• What precisely is Money?
• Money has three distinct aspects.
• In practice, money is defined as cash plus certain bank
accounts.
Aspects of Money
1.
2.
3.
Medium of Exchange – Token that can be offered as
a payment for goods.
Unit of Account – All goods will have a value in
money and, thus, can be used to measure all goods
Store of Value – If money is to be accepted for
goods today it must have durable value. (Money is
an Asset).
Categories of Money
1. Definitive Money
Definitive Money (sometimes known as monetary base):
Money that can be used to finalize transactions.
•
•
Currency+ Reserves
Banks keep reserve accounts at central bank
•
•
in HK these are called Clearing Balances.
When check/electronic transfer requires payment from
one bank to another, the transaction is finalized with a
debit of one banks account and a corresponding credit to
another.
Central Bank Balance Sheet
Monetary Liabilities
• Currency: Paper Money is typically issued by central
bank. Coins are sometimes (as in HK)
• Currency Held by Non Bank Public
• Currency Held by Banks aka “Vault Cash”: includes
money ATM machines.
• Deposits of Banks: Banks keep accounts at the central
bank to facilitate payments and meet regulatory
requirements.
An average of 4.6% of currency in circulation
in USA is vault cash. In HK, 7.5%
Categories of Money
2. Broad Money
Broad Money: A set of assets, typically some
form of bank deposit, which can be used for
transactions through some process.
• Checking Accounts,
• Savings Accounts
• Liquid Time Deposits and CD’s
19
Categories of
Broad Money
M1
M2
M3
M1 Currency
+ Checking Acct.
M2 M1 +Savings Acct.
+ “More Liquid”
Time Deposit
M3 M2 + “Less Liquid”
Time Deposit
Hong Kong
Monetary
Aggregates
1. Overwhelming
quantity of funds
held by fully
licensed banks
and are counted
as M2.
2. Restricted
License Banks &
Deposit Taking
Companies
deposits are in
incremental M3
but are small.
3. Only about 6% of
M2 is currency.
Legal
tender notes
and coins
in hands
of public
323,137
M1
1,081,475
Demand
deposits
with
licensed
banks
758,338
Savings
deposits
with
licensed
banks
2,126,496
M1
1,081,475
Time
deposits
with
licensed
banks
1,817,200
NCDs
issued by
licensed
banks
and held
by public
115,110
Deposits
with RLBs
M2
& DTCs
5,140,282
10,838
HKMA Statistics HK$Millions
M2
5,140,282
NCDs
issued by
RLBs
& DTCs
and held
by public
0
M3
5,151,120
Money Supply vs. Monetary Base
Monetary
Base
*
Money
Multiplier
=
Money
Supply
Money Multiplier
• The money multiplier can be derived by the ratio of money to the
monetary base.
Money Cash  Deposits


Base
Cash  Reserves Cash
Cash
1
Deposits
 Reserves
Deposits
Deposits
• As long as the reserve ratio is less than 1, the money
multiplier is greater than 1.
• Multiplier is decreasing in reserve-deposit ratio and
decreasing in cash-deposit ratio.
Fractional Reserve Banking
• Banks keep only a fraction of any deposits they
receive on hand in the form of vault. The rest is used
to acquire other assets, especially loans.
• Regulatory Requirements – Some regulatory regimes
have minimum reserve levels.
• Most developed economies have either rr= 0 (e.g. HK)
or modern banking techniques make them nonbinding.
Reserve Ratio = Required Reserves Ratio + Excess Reserves Ratio
(Reserves/Deposits) = rr + ER/Deposits
Monetary Policy
China
PBoC uses
frequent
changes in rr
to manage
liquidity in
the banking
system.
China's Evolving Reserve Requirement, BIS
WHY DID WE CARE ABOUT MONEY
AND WHY DID WE STOP
Money and Inflation
• Money is a tool for transactions and like all
tools has been subject of technological
advance (from beads to Octopus cards).
• However, degree to which society can take
advantage of this technology depends on policy
choices particularly regarding inflation.
28
Great Inflation of the 70’s & 80’s
CPI Inflation, % Annual Rate
35
30
25
20
15
10
5
OECD
East Asia
Subsaharan Africa
20
09
20
05
20
01
19
97
19
93
19
89
19
85
19
81
19
77
19
73
19
69
19
61
-5
19
65
0
Latin America
Quantity Theory
• Simplest monetary theory is the Quantity
Theory of Money.
• Purchasing power of money is equal to the quantity
of money (Mt) times the speed of circulation (V, # of
transactions)
• Purchasing power means # of goods (Yt) multiplied
by price per good (Pt)
Mt * Vt = Pt * Yt
Rule of Thumb
• Rule of Thumb The growth rate of product is approximately
equal to the sum of the growth rates of the elements of a
product.
Z t  X t  Yt  g  g  g
Z
t
X
t
Zt  Zt 1
g 
Zt 1
Z
t
Y
t
Money and Inflation
• Assuming stable velocity
g  g  t
M
t
Y
t
t  g
P
t
• Inflation occurs when money growth speeds
ahead of output growth. The unbounded
creation of fiat money leads to inflation which
ultimately will make the money worthless.
Money & Inflation: 1975-1994
Inflation & Money OECD Countries
0.2
0.18
Average Inflation Rate
0.16
0.14
0.12
0.1
0.08
0.06
0.04
0.02
0
0
0.02
0.04
0.06
0.08
0.1
0.12
Average Money Growth
0.14
0.16
0.18
Monetary
Targets
Bundesbank Money Growth Rate Target
10
9
8
7
6
5
Lower Bound
Upper Bound
4
3
2
1
0
1975
1976
1977
1978
1979
1980
1981
1982
1983
1984
1985
1986
1987
1988
1989
1990
1991
1992
1993
1994
1995
1996
1997
1998
%
During the
battle against
inflation,
many central
banks would
set targets
for the
growth of
money.
Bundesbank targeted Base 1975-1988, target M3
from 1988-1998 Link
34
Money Target Transmission Mechanism
• Breakdown in stable relationship between money
supply and the economy has made this approach less
popular in developed economies.
Unpredictable relationship
between bank reserves and total
money supply. Multiplier is
volatile.
?
Monetary Base
Money
Unpredictable relationship
between total money supply and
economic activity. Velocity is
volatile
?
GDP
Link
Link
37
Quantitative Targets
•
Link
Back
Money Free World
• New payment mechanisms make paper less important.
• If money is memory, why do we need money when the internet
remembers everything.
• Currency: September 4, 2014 345,817 million Pop. 7.15 million
• About 50k per man, woman and child. How much is in your
wallet?
• Money is anonymous.